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Opinion - Accountancy


We need takers for the bad loans too

Ashwani Puri

Ashwani Puri on the role of independent NPL investors in the asset reconstruction company model

GLOBAL experience shows that independent or third party investors (that is, other than the original lenders) often make an important contribution in unlocking value from non-performing loans (NPLs), not merely by allowing lenders to exit these assets expeditiously, but also by applying resolution and turnaround expertise, persistent follow-up, creative solutions and fresh financing where appropriate.

Conscious of the high-return expectations of own fund providers from high-risk NPL resolution activity, NPL investors recognise the importance of early resolution. While there are instances of NPL values increasing over time because of industry or business cycle revivals, analysis of the factors in the true carrying cost of NPLs clearly demonstrates that delay is a significant destroyer of NPL value in a majority of the cases. This is even more true where financial stress causes the underlying business to cease operations, resulting in deterioration in plant, machinery and inventories, non-recoverability of receivables and dissipation of customer and other relationships, brand value and goodwill.

Purposive resolution or revival efforts for the borrower business driven by consciousness regarding the carrying cost, and an ability to inject management, technical and financial resources if warranted, often enable independent NPL investors to extract better value; even where revival of the borrower business may not be feasible, early action for sale of underlying business or assets may still result in better value realisation in almost every case, except possibly from real estate collateral.

As in other countries, independent NPL investors can make a substantial contribution to the unlocking of value from NPLs in the Indian financial sector for the reasons mentioned. In Korea, KAMCO acted as a Government supported conduit for acquisition of non-performing loans before these NPLs were auctioned to independent NPL investors who took lead in their resolution. KAMCO, the asset management company of Korea, had limited role in the actual NPL resolution process.

In Taiwan, independent NPL investors acquired NPLs in auctions conducted by the banks and focused on their resolution. The Peoples' Republic of China, currently one of the largest NPL markets in the world, is also encouraging involvement of independent NPL investors in the NPL market in China. A quick review of NPL deals in China suggests that independent investors have acquired NPLs worth over $6 billion in China over the past three years.

The Indian model is much more challenging as it envisages multiple asset reconstruction companies (ARCs), operating competitively in a private sector framework, with no direct government fiscal or other support. While reliance on market forces may be justified by significantly lower NPL levels in the Indian financial sector, involvement of independent/third party NPL investors becomes even more critical for strengthening the financial position of Indian banks in absence of Government funding.

Currently, banks/financial institutions continue to hold security receipts which are in the nature of pass-through certificates, linked to the eventual value realisation on the assets transferred by them to an ARC. While they are able to remove the NPLs from their balance-sheet as a part of loan assets, they continue to carry these as investments and, therefore, remain exposed to value realisation on these NPLs even after their transfer to ARCs.

While some banks find this an adequate inducement to transfer NPLs to ARCs, others are reluctant to do so unless there is a cash consideration, immediate or deferred, and a true transfer of risk. This understandable reluctance to transfer NPLs to ARCs, with attendant ceding of influence on resolution, without definitive consideration and risk transfer is impeding the NPL resolution efforts. Banks who have transferred their NPLs would also prefer an exit option. The existing ARCs, ARCIL and now ASREC, are essentially multi-lender in nature, and have limited financial capability to provide cash consideration for NPL acquisitions, liquidity or exit option for security receipt holders and to advance money, if required, for revival of distressed cases.

Multi-lender ARCs can play an important role in the overall continuum of NPL resolution in India. Multi-lender-owned ARCs are better placed (than private-investor-owned ARCs) to achieve debt aggregation requirement in view of their existing lender relationships. Typically, medium- to large-scale businesses in India would have anywhere between 5-8 lenders, or even more, providing term loans, working capital and other financing facilities.

Owing to differing ownership patterns, accountability, resource pools, liquidity situations, balance-sheet positions, regulations and management, participating lenders often have differing perspectives. In many cases, defaulting borrowers have successfully exploited these inter-creditor issues. At times, borrowers have deliberately treated different lenders differently to reduce the chances of joint lender action. In this context, aggregation of financial stakes held by different lenders became a critical requisite for resolving any NPL.

Aggregated debt increases the ability to put pressure on the defaulting borrower and facilitates restructuring or enforcement of security, if necessary. Both lender-owned ARCs with focus on aggregation and investor-owned ARCs with focus on resolution are complementary to each other.

In a study to improve the ARC framework, carried out on behalf of the Finance Ministry, it has been observed that these independent NPL investors find Indian NPL market attractive in case there is a demonstrable deal flow and NPL transfers take place at realistic valuations.

Further, control of NPL investments is the first requirement of these investors, because, with significant investments in risky assets, these investors like to be able to control and influence the resolution strategy of NPLs acquired by them. In addition, a few clarificatory changes would be required in the existing regulatory regime, particularly in tax and legal areas, to facilitate investment structuring and remittance of their investments.

(The author is Executive Director, PricewaterhouseCoopers Pvt. Ltd.)

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